Reasons For The Recent Decline In Gold Prices

September 12th, 2014 by Trefis Team

Gold prices fell to their three-month lows in September. ((Gold Slides to Three-Month Low on Easing Ukrainian Tension, Bloomberg)) The London PM Fix gold price stood at $1,286.50 per ounce at the beginning of the month, with prices closing at $1,251 per ounce at the close of trading on September 10. [1] Gold is often viewed as an inflation hedge and safe haven investment by investors. Thus, gold prices are to a large extent influenced by a set of related factors including the macroeconomic outlook for the U.S. and world economies, the performance of alternative assets such as equities and the U.S. Dollar, the trajectory of interest rates and geopolitical uncertainty. In this context, we will look into the reasons for the recent decline in the prices of gold.

U.S. Macroeconomic Data

The Manufacturing Purchasing Managers Index (PMI) measures business conditions in the manufacturing sector of the concerned economy. When the PMI is above 50, it indicates growth in business activity, whereas a value below 50 indicates a contraction. The manufacturing PMI has consistently registered values of over 50 for all months in 2014. ((U.S. Manufacturing PMI, Trading Economics)) As per PMI data released by Markit Economics, manufacturing activity in August was the busiest since April 2010. [2] An improvement in conditions in the manufacturing sector points to a general improvement in macroeconomic conditions in the U.S. This has led to the strengthening of the U.S. dollar and has fueled expectations of an increase in interest rates.

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Strengthening U.S. Dollar

Positive U.S. macroeconomic data has led to the dollar strengthening against a basket of other currencies. The U.S. dollar Index, which measures the value of the dollar relative to the majority of its most significant trading partners, has risen from a value of 82.75 on September 1 to 84.28 on September 10. [3] Investors expect that improving macroeconomic conditions in the U.S. may lead to a sooner than expected interest rate hike by the Federal Reserve.

Interest Rates

With the economy strengthening, the Fed is expected to raise interest rates some time in 2015. However, the timing of an interest rate hike is contingent upon the pace of economic and jobs growth in the U.S. [4] Current indications are that the Fed is weighing up revisions to its interest rate guidance of “low rates for a considerable time”. [5] Investors are keenly looking out for cues from the Fed pertaining to the timing of an interest rate hike. A rate hike is likely to lead to a decline in the price of gold, as investors shift towards interest bearing assets.

European Central Bank Interest Rate Cut

The European Central Bank (ECB) recently cut interest rates, in addition to announcing two bond purchase programs, reflecting concerns over low inflation in the Eurozone and the threats to the region’s fragile economic recovery. [6] However, the impact of the ECB’s actions may be mixed. While gold may benefit from greater investment demand as traders hedge against excessive monetary stimulus, the ECB’s actions will also weaken the Euro and strengthen the Dollar. [6] This would make dollar denominated gold contracts more expensive for buyers that use other currencies, and thus, temper the demand for gold.

Easing Geopolitical Tensions

Easing tensions in Ukraine and the Middle East will reduce geopolitical uncertainty, and consequently demand for gold as a safe haven asset. The withdrawal of two-thirds of Russia’s troops stationed in Ukraine from the country post a truce signed on September 5, signals the easing of the Ukrainian crisis. In addition, violence has also eased in the Middle East. [7] A more stable geopolitical scenario has also put pressure on gold prices.

The Road Ahead

Due to the fall in gold prices, the stock prices of major gold producers have tumbled. Barrick Gold (NYSE:ABX) and Newmont Mining (NYSE:NEM) have registered a 7% and 5% decline in their stock prices this month, respectively. [8] Gold prices in the short term will be influenced by the interplay of the factors discussed above. With a strengthening U.S. economy, an interest rate hike looks likely, with only the timing of such a hike uncertain. In the absence of any major geopolitical disruptions, gold prices are expected to weaken further. This is bad news for the likes of Barrick and Newmont.

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Notes:
  1. Historical Gold Price Charts, Kitco [↩]
  2. Upbeat Economic Reports Signal Sustained Improvement, Wall Street Journal [↩]
  3. U.S. Dollar Index Chart, Bloomberg [↩]
  4. Janet Yellen Warns of Uncertain U.S. Economic Outlook, Financial Times [↩]
  5. Federal Reserve to debate new language on interest rates, Financial Times [↩]
  6. Gold Slips on Dollar Strength, Palladium Climbs on Russia, Wall Street Journal [↩] [↩]
  7. Gold Slides to Three-Month Low on Easing Ukrainian Tension, Bloomberg [↩]
  8. Stock Prices, Google Finance [↩]